Friday, February 21, 2014

I am out of tune with these times

At core I am an old-fashioned value investor. Maybe a growth-orientated one - but the valuation has to make sense on fairly modest assumptions before I get excited.

I owned Facebook in the twenties. I could make the per-subscriber numbers work - and it was a mid-single digit times revenue and it seemed a fairly good bet that revenue would rise a lot and that margins on that revenue would be good. I am not averse to paying six times sales for businesses that are growing fast if the end-margins are likely to be good.

At the time the (incorrect) consensus was that Facebook would not manage the transition to mobile.

I sold my Facebook holding as it went up. Too early I regret - and at least in part unintentionally. I purchased the holding by writing put options perfectly happy to have the stock put to me. I sold by writing call options, modestly happy if it was called. I just had a buy-price and sell price in my head based on what I thought were sensible valuations and decided to pocket a little premium around them. [This is almost the only stock Bronte has ever acquired this way. We did it because the option premium was extraordinarily high and we figured the business was far less volatile than the stock.]

These days I am no longer so in tune with valuation.

Yesterday Facebook did an acquisition that makes no sense to me. I had previously - on Twitter - questioned the $900 million paid by Rakuten (in Japan) for Viber. But that price looks modest compared to the price paid for the (much better) WhatsApp.

Obviously this makes sense to somebody - and indeed to people who are far cleverer than me. I don't want to second-guess Mark Zuckerberg who has done things and built things and added more value in a week than I might in a lifetime.

But I would have laid a large bet that Facebook stock would finish down after that acquisition rather than up and I would have been wrong.

I used to be an unremitting bull on the market (a position that is deeply uncomfortable for someone whose skills and inclination are on the short side). I am not bullish now - and have positioned far closer to neutral than any time in Bronte's history.

But I am not comfortable with that position either. Clever people are doing things I don't understand and I am just feeling old and tired.

38 comments:

Thank you for saying what few others has the galls to say. Traditionally I have invested in cash flow rich companies which had not performed as well as tech in the last year. I have been looking into tech but I cannot understand how these names are trading. The prevalent perception in the industry is that if an investor cannot beat the market, then they are not a good investor. But who should we be trusting during abnormal times? The market, or the investor?

John if you are a global investor and feel old and tired, I can assure you looking through the Australian stockmarket I feel like a neaderthal in need of a serious hibernation. Profit growth generated by putting non recurring items (which recur every year) below the bottom line, in an economy where the prevailing view - with no analysis - is that "we'll muddle through" because we always do. As for the social media stocks, I suppose we learned years ago from AMZN that even the greatest business models have trouble being monetised but short selling them is the way to the poor house. You might feel frightened, but you're not alone!

First, a few assumptions:1. We assume WhatsApp has essentially no opex if it is layered on top of FB messenger infrastructure.2. WhatsApp eventually reaches 1 billion users3. People willing to pay $1/year are willing to pay $2/year or more.

At $2/year and a billion users... are we somewhere less than or near 12x earnings? This is forgetting about any possible side service they could provide -- stickers, video chat, etc.

The only thing that matters is the time spent inside an app. Facebook bought x minutes of y people and believe they can turn it into $.

Think of it like buying a TV stock minus the content creation charges but with the ability to tailor ads to each individual user. That may not justify the valuation but its important to think of it as more than a messaging app. There are also 450 million user's messages unencrypted on a server ready to mine as well.

Biotech is a joke. As someone who spent ten years working in a lab, it costs too much, the results you get are always difficult to reproduce and, worst of all, very easy to manipulate. Some of the things/decisions I've been told and witnessed make it difficult to ever recommend investing in a Biotech stock that does not have a verifiable product.

People compare it to hardware but really it is hardware if the laws of physics changed every time you tried to do something new.

If you are ever interested in talking about it further let me know and I can get in touch.

I'd wager that your intuition is correct. FB just spent a ransom on a messaging app with no "moat" and most talking heads are justifying it because of its node size. Metcalfe's law does apply, but I also think exclusivity matters in networking, and the kids will abandon snapchat and whatsapp when the helicopter parents start photobombing and the app becomes a tether instead of a portal.

"Clever people are doing things I don't understand and I am just feeling old and tired."

Not so fast Mr. Hempton. The jury on whether this really made sense is still out.

It may well have provided an opportunity for speculative gain in the short term, but is that truly a measure of "making sense"? I would like to think not.

How about the long term? How are FB going to get their money back on this deal? That is going to be tough and there are many examples where such acquisitions didn't work out and the acquired businesses were sold at a serious loss several years later.

The latest example was Google's Motorola Mobility divesture, an earlier example was Ebay's divesture of Skype.

Sometimes such acquisitions can even cause the death of a major market player. Compaq took too much on their plate when they acquired DEC and became a takeover target for HP as a result.

Yet, whenever there is rumours that HP might get right of all that ballast acquired with Compaq, their stock goes up, which is generally being interpreted that the value of HP's printer business is higher than the value of HP as a whole. If so, then these assets acquired from Compaq must have negative value. And indeed, HP is a shadow of its former self.

It would seem that for the most part, investors do not really care whether an acquisition makes any sense for the acquiring company. The bulk of them get excited about the short term opportunity to make a few bucks on the likely movement of the stock in the aftermath of an acquisition.

Whether the acquiring company actually can make their money back on the deal does not seem to be of any interest to the bulk of investors because they don't hang around for that long.

Let's face it, the bulk of these big mergers and acquisitions go wrong and hurt the companies involved in the long term.

That FB finished up after gaping lower is perhaps a sign we are entering the final stage of the MoMo rally. I too would have thought it finished down. You buy FB stock for exposure to FB, not for Zuck empire building. All these ways to justify the price tag are interesting, but unlike Youtube or the Skype acquisition, FB already has a messaging platform (and quite popular). So what does it say about the strategy of FB. We wont compete, we will buy (using shares as currency). Not good s/h value IMO.

Last point, I love the user argument. How many years have any of these Apps been around for. What makes thier business model so sustainable? I have a great messaging app that i use with all my contacts. Its called eMail!

As much as I disdain Apple's closed ecosystem and dont understand why they cant release more products, I'll give them credit in the S/h value department. They didnt buy BBRY, they killed it. Created iTunes and are in a great position to capitalize on 'wearable' tech. FB might want to take notice

I'm not going to make a comment on the price paid for Whatsapp, but I believe I understand the rationale behind the acquisition. Though I try not to reflect to much on my own preferences when conducting investment anaylsis, in this instance I think it can provide some insight.

Many users use Facebook for the ability to chat. I am one of those users. I actually do not care about the other features of Facebook. Before Facebook I used IRC, ICQ, SMS, MSN, Skype, even email. I always migrate to the platform with critical mass. Most recently this was Facebook. Today it is Whatsapp.

Why? Everyone I know with a phone has whatsapp. If they don't I've successful at convincing them to get it.

I get in touch with friends and family on Whatsapp who I could not reach through Facebook (because they are not there). My mom is an example. Since getting whatsapp I've barely used Facebook.

I like whatsapp because I can see when my friends are online, if they have received my message, I can send photos and videos and I can specify groups when I want to send e.g. cute pictures of my dog to all my friends. It also caters to my online paranoia - up untill recently I was of the impression that my chat logs are not analysed to provide me with targetted advertising, etc. I might have been wrong.

Now Facebook owns the app that was beating them at chat and can access more "big data".

They even know what I tell my mom.

Facebook might perhaps also make adjustments to Whatsapp that encourages idle users to get back to Facebook.

The value of Whatsapp to any other buyer would be a fraction of what Facebook payed, however, I immediately appreciated Whatapps strategic importance.

That said, I do not think it makes Facebook a good investment. It just delays the process of user getting bored with the site and seeking out alternatives.

I also believe the process of Facebook monetising its user base bears a high risk of alienating its users. There is too high risk of an implosion to justify an investment.

On a side-note, in the next five years we might see an anti-movement to social media and big data. Not as a direct threat to the incumbents, but as an investment opportunity in companies who capture the niche who is already alienated by big data.

Do you miss the good old days when your phone did not track your precise location at all times, internet browsing was anonymous, and chat applications didn't profile you?

I am still seeking a practical solution to this problem and I would be willing to pay up for it.

Curious to see if that GOOG position eventually shows up in a follow-up post on the investor theory from the Blue Nile post... I'm waiting in the wings to become a Value buyer on that once the Growth team gives up.

The search business is amazing, but the company has so much cruft it could cut if it actually wanted to be run for profits.

I do data mining (in my case, actually more predictive analytics) for a living. And I never invest in tech. Oh, I believe the future is rosy enough--I'm just concerned that I'd fool myself. And honestly, I don't think I understand it well enough to know what differentiates the companies who wildly succeed from those who do not.

It is possible that tech investing really is a cross between a random walk model and a very difficult, largely intractable deterministic model. Even if you're good, you might not be good enough.

Lots of clever people do things that seem clever on front end, but turn out to be not so clever. Don't underestimate your abilities to see/not see what's going on, John.

Facebook is likely in a bind, pay up for more users or get stuck with an antiquated biz model in which users spend less and less time on your core product. If that is the case, clever can be substituted with desperate.

On a side note, most of the individuals I know who jumped on the the snapchat and tinder train have jumped right back off.

The stock market overshoots on the way up, then it overshoots on the way down. That's the nature of the beast. I certainly don't understand the frenzy surrounding tech stocks these days - I mean, I used to love YELP, and now I trust it about as much as the manager of an old-fashioned Chinese reverse merger. Maybe I'm out of touch too, but I didn't understand the valuations back in 2001. And there was a lot of crap out there in 2007 that didn't make a lot of sense either. If you factor too much market feedback into your long-term value calculations, you're gonna lose your hat.

Remember that out-of-touch guys who shop at JOSB still do some decent volumes - their "fear purchases" of tech may just be beginning. And I'd wager the recovery from the initial drop after the Whatsapp-FB announcement came from guys who heard some SV guru's blessing of the deal before his words hit the presses - they're all out of the stock now, but their purchases are still on the tape.

And returning to my original point, where's the 10 year Shiller PE these days, 26? Every bear market is preceded by a bull one...

I don't wanna ramble on too long, but if you don't get a stock, don't buy it. And if a catalyst appears in the near future, considering shorting it. I know you know this very well John - I think you're a lot smarter than I am, especially on the subject of markets. But you've certainly made it sound like you're scratching your head here, and my prescription is a rehashing of some very basic market principles.

John,I share your frustrations. As a London based Value investor, this feels like I'm reliving late 1999 / early 2000. The daily volatility, the lack of any sense in valuation, acquisitions pricing etc suggest that we're close to the top and it will turn. For me, the real question is how close 'close' really is!John.

I was a hedge fund manager for 20 years, running a GARP style fund. The middle of those 20 years was in 1998-1999, and I felt the same way you describe yourself as feeling now. The only thing you can do is to stay consistent in your investment approach. (I recently saw a headline that value investors need to jump on the Tesla bandwagon.)

Of course, Keynes' perhaps apocryphal comment about the markets staying irrational longer than you or I staying solvent is also true, but having read your blog for some time, it's pretty clear to me that you know how to play the game.

Keep fighting the good fight. I have no doubt that you will (some day) be proven right.

For what it's worth I feel the same way about this acquisition. I'm 30, with a tech background (soft. eng) but currently working in business dev. So it's not just a generational thing - you're probably right to be baffled.

Looked at as a purchase for $19B it simply doesn't make sense. That's nearly $50 LTV for each user they are acquiring - ignoring the fact that there will be overlap with their existing userbase. Where are they going to earn that? Even if userbase doubles, $25 LTV, on average, across a BILLION users seems like more than a stretch.

There is also no barrier to entry for a Whatsapp - you are just buying network effects here.

So the best explanations I've heard here are the ones that speculate that even FB think that FB stock is overvalued, and they're using their leveraged currency to purchase a competitor.

Warren Buffett is right (http://www.itproportal.com/2011/03/29/warren-buffett-social-networks-are-overpriced/). These stocks are not just overpriced on average, but extremely hard to value. We don't know how long individual social networks are going to remain popular, and we don't know much about what makes some longer-lived than others.

We do have some indicators. In 2007 MySpace was trendy and valued at $US12 billion. In 2011 it was untrendy and valued at $US350 million. What changed? The consensus amongst teenagers. Could that blow Facebook apart too? Easily.

Perhaps different user base but most people in the Sino Asian community are all on Wechat instead of Whatsapp and you can see Wechat surging to 500m+ user base easily. When Tencent pushes their global expansion for Wechat there will be some serious pain for FB/Whatsapp.

"I owned Facebook in the twenties. I could make the per-subscriber numbers work....." What with a magic fairy wand....love to see those assumptions....I guarantee with 100% certainty that at least one of those will prove so wrong inside 1 yr to invalidate your entire valuation model.

Perhaps FB is like News in that because of the control situation you are buying on one man's decision making, not company valuation. "Catch the vision or catch the bus" style as per Jobs era at Apple, Bezos at Amazon et al.

Hence Mark Zuckerberg will probably have his own fair share of DirecTV, MySpace, WSJ type of deals over the next few decades.

I agree with David Walker. How do we know that the value of a social network is truly proportional to the number of users, or the square of the number of users. Rather, mightn't it be proportion to the number of COOL users?

In that sense, a social network might be a bit like a trendy nightclub. A nightclub is more valuable if it is jam packed than if it is empty, but it makes a difference if the people lined up outside are beautiful women or slobby guys. After a couple of trips to a nightclub of twerking with a potbellied middle age guys, the club is no longer cool.

I've noticed similar patterns on virtually every network I've been on. Initially I easily connect to lots of people similar to myself. Then I try to connect to people who could improve my social or professional life in some way. Many ignore me. Then I get annoyed by connection requests from people who previously annoyed me in real life.

My second concern is that all of these companies, both social and search, have the same business model: targeted advertising. One, how big is the total advertising market? And two, how much does targeting really add?

Most products I purchase are branded products that I've learned to trust, but brands are built on broad based name and quality recognition, not targeted advertising. Targeted advertising is more about click-baiting, i.e., trying to insert an ad click as an intermediate step before a final purchase decision I might very well have made anyway, especially for a well-branded product. Advertising isn't my specialty, but color me skeptical.

Just buy Tesla and hold long term. Whatsapp was in all likely hood a bad mistake but not necessarily irrecoverable for FB. All I can think of at the moment is how Elon Musk is changing the world. The new Giga Battery factory is another game changer.

30% lower battery cost along with increasing storage capacity very well could spark.. an energy revolution. 30% lower overall energy costs are not out of the question. 30% or greater reductions in transport costs are possible. Lower injury levels fewer fataities...i'm thinking about smart cars with proximity sensors and auto correct capabilities. Health benefits from lower air pollution levels are going to be significant. All this improvement along with other efficiency gains possible with smart phones could lead to significant capital available for deployment in other areas like education health culture social welfare housing etc. Thanks to Elon, Serge and Larry and Steve Jobs and Steve Jurvetson and co the future is looking generally a lot better and more exciting. Don't feel old grab the moment but remember always use protection.

FB is a dead man walking. Teens aren't using it/avoiding it and when they move into their 20s FB loses a very important premium advertising market. The WhatsApp deal is desperation to fill projected growth gaps. FB is now obsolete tech and WhatsApp has no monopoly value. Kids switch to the latest app, there is no 'stickiness' in brand loyalty.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.